The Problem is Economic, but the Solution is Political
Executive Summary
The primary surplus targets of 1.2% of GDP for 2015 and 2% for 2016 are welcome, but will only lead to a drop in the debt/GDP ratio if microeconomic reforms are carried out that boost economic growth and create conditions for a decline in the real interest rate. S&P has given Brazil the benefit of the doubt by deciding to wait and see whether the fiscal adjustment and the announced reforms lead to faster growth. But this has not been the market’s reaction, with the quotations of Brazil’s CDS continuing to rise even after Joaquim Levy took over as finance minister.
That risk premium behavior is due partly to the crisis faced by Petrobras, which has not yet managed to publish its balance sheet. But this is not all. The other key factor is the eroded support for the administration in Congress. The PMDB reacted to attempts by the administration to reduce its importance in the governing coalition and threw its support for the election of one of its members as president of the lower House. The party has not been frontally blocking discussion and voting on the measures proposed by the government, but it has been using all the internal procedural rules to postpone the debate and voting. Besides this, it has been proposing its own agenda, not always favorable to the government. This stance distances the PMDB even more from the coalition and accentuates the political conflict.
This is not a situation favorable to approval of the necessary reforms to spur growth and help the fiscal adjustment, which everyone knows will have a high cost. In this Report we show evidence that a large part of the recent depreciation of the exchange rate is associated with the increase in the risk premiums, whose growth comes mainly from the political arena. The risk also exists of closing a vicious circle, with the political difficulties accentuating the depreciation and inflation, reducing the government’s popularity even more.
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